Strategic Investing Through Retirement with Stephen Tuckwood, CFA

January 8, 2024

Strategic Investing Through Retirement with Stephen Tuckwood, CFA

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Strategic Investing Through Retirement with Stephen Tuckwood, CFA Show Notes

Our Director of Investments, Stephen Tuckwood, CFA, has quickly become one of the most frequently featured guests on The Guided Retirement Show. For the Season 10 premiere, Tuck and Dean Barber will discuss the critical topic of constructing the right portfolio via strategic investing as you transition into and go through retirement. They’ll discuss the nuances of proper portfolio construction and the changing dynamics of investment rules during the retirement phase.

In this podcast interview, you’ll learn:

  • There’s a Change in Mindset with Investing While in the Retirement Redzone
  • Asset Allocation Is More Important Than Stock Selection
  • Pure Asset Allocation vs. Strategic Asset Allocation
  • The Three Tax Buckets
  • Active vs. Passive Management

Understanding the Shift in Investment Rules During Retirement

As Dean and Tuck kick off their conversation, they emphasize the pivotal shift in portfolio dynamics when transitioning from the accumulation phase to retirement. The accumulation phase involves aggressive saving and growth strategies, while retirement demands a shift toward distribution.

“I think the rules of investing change once you get to retirement and even the two to three years leading up to retirement. It becomes more about making sure that your portfolio can generate income safely and keep up with inflation.” – Dean Barber

We like to view those few years leading up to and after retirement as the retirement red zone. It’s a timeframe where the market can significantly impact your financial success later on in retirement if there’s a major stock market correction during that time.

Challenging the Rules of Thumb

Dean brought up the concept of investment rules of thumb, such as owning one’s age in bonds or following the 4% distribution rule. However, Tuck cautions against relying solely on these rules, emphasizing the importance of considering market conditions and the dynamic nature of yields in the bond market.

“Rules of thumb are usually directionally accurate and OK to look at, but the devil is always in the details with these types of things.” – Stephen Tuckwood, CFA

For example, current yields in the bond market are materially different than what they were 12-18 months ago. That might impact your allocation to bonds relative to stocks as you’re looking at the comparison of the two markets. There’s obviously a lot more that goes into it than using rules of thumb.

Four Key Aspects of Retirement Portfolio Construction

There are four key things that Tuck and Dean really want to dive into as it relates to strategic investing through retirement. Those four things are:

  • Asset Allocation
  • Strategic Asset Allocation
  • Asset Location
  • Asset Class Implementation

1. Asset Allocation

Let’s start with asset allocation. Tuck says asset allocation the biggest driver of a portfolio’s return over time. When thinking about building a portfolio, a lot of people immediately think about what stocks are in there. The reality is that your broad asset allocation—that mixture of stocks and bonds for the portfolio—is the primary factor that drives portfolio returns over the long-term.

 “(Asset allocation) is the No. 1 driving factor. Stock selection isn’t as impactful in the long-term. Getting (your asset allocation) right is critical.” – Stephen Tuckwood, CFA

There’s Still More to It Than Pure Asset Allocation

Tuck was clear that asset allocation is of the utmost importance when it comes to strategic investing through retirement. But in retirement, you’re not just looking for long-term performance. You need your portfolio to produce income. You may need to have a systematic withdrawal set up and be forced to sell positions at lower prices than what you wanted to if all you did was pure asset allocation.

That can be dangerous, though. Think about this. If you have traditional IRAs, you’ll eventually be subject to taking Required Minimum Distributions. If you just turned 73 in 2023 or will turn 73 prior to 2033, your RMD age is 73. That means that your first RMD needs to be taken by April 1 of the year after you turn 73. Keep in mind that if you wait until the early part of that next year to take your first RMD, you’ll need to take two RMDs in the year that you turn 74. The RMD age will bump up to 75 by January 1, 2033.

“That’s a liquidity event that you need to plan for and position your portfolio for. That’s the key to good liquidity management.” – Stephen Tuckwood, CFA

Buying Low and Selling High During Large Market Drawdowns

If we happen to have a large drawdown in the equity or fixed income market, you don’t want to pull money from your portfolio at that time. It’s quite the opposite. Tuck advises to buy low and sell high. Add to those asset classes when they have material drawdowns to fund a distribution.

We need to adapt portfolios as the markets adapt. The markets are constantly in flux, so we’re constantly adapting portfolios. Fixed income is one of those unique asset classes where the bigger portion of returns is what you pay for the bond. You’re locking in that yield to maturity.

Within fixed income, you’re looking at two things. One is the amount of duration and interest rate risk that you’re taking. How far on the yield curve are you willing to go? The other is the credit risk. Treasuries are a risk-free asset. When is it appropriate to add corporate bonds, municipal bonds, and high-yield bonds?

Focusing on Total Return

When our CFP® professionals build out financial plans, they’ll oftentimes see when a couple might need to have a distribution rate in the 4-5% range. Even with interest rates where they are today, it’s difficult to get that type of yield to produce the income that the couple needs and keep up with inflation.

It’s important to focus on total return in retirement and not just income generation from investments. That tends to be what we see from DIYers with portfolio construction.

“They have the idea of always protecting principal and only ever drawing on the income that’s produce. That often limits the longer-term growth potential of the portfolio.” – Stephen Tuckwood, CFA

Creating Your Own Yield

Another way to approach that is to have a desired yield that the portfolio needs to produce to maintain your lifestyle. You can create your own yield from being in growth assets that appreciate over time and then trimming those back using the corpus of the portfolio to generate that return.

“It’s not always the best approach to just maximize yield on a portfolio and leaving very little growth on the body of the portfolio.” – Stephen Tuckwood, CFA

Let’s say that you need a 5% withdrawal. That means you need a total return of 8% to keep up with inflation and increase your income over the years so that your lifestyle doesn’t diminish. This is where we shift gears from pure asset allocation to strategic asset allocation as we discuss strategic investing through retirement.

2. Strategic Asset Allocation

When we think about proper portfolio construction and strategic investing through retirement, it’s a very personal situation. Every portfolio will and should be different because each person has different goals and objectives. Strategic asset allocation focuses things back on the financial plan.

We’re very financial plan-focused here at Modern Wealth. That’s our North Star when it comes to portfolio construction in that the client has gone through a risk tolerance type of discussion and shared other life events that they’re planning for.” – Stephen Tuckwood, CFA

The job of the portfolio is to achieve a household or individual’s financial goals with the least amount of risk. That’s a very different discussion that just talking about portfolio construction in general, where you’re just looking into maximizing a return, finding a yield target, etc. The financial plan brings it back to the client and makes them the focus.

Your Personal Return Index

Dean and Bud Kasper, CFP®, AIF® coined the term “Personal Return Index (PRI)” several years ago. What does your money need to do to get you to where you want to go and allow you to do all the things you want to do. And how do you construct your portfolio to do that with the least amount of possible risk? That’s a huge component of strategic investing through retirement.

3. Asset Location

The conversation of strategic investing through retirement goes one step further when you tie in asset location. You can work with a CFP® Professional about how to construct your portfolio, but then you need to bring a CPA in to determine what tax bucket you put your stocks, bonds, or alternatives in. There are three tax buckets: taxable, tax-free, and tax-deferred.

The Three Tax Buckets

With your taxable account, every decision you make within your portfolio is going to subject to taxes. If you reduce equity exposure there, there’s likely going to be a tax bill that needs to be paid.

With your tax-deferred retirement accounts, the money enters your account on a pre-tax basis, grows tax-free, but becomes taxable when you take the money out.

Then, you have your tax-free bucket. That money is taxed at the time of the contribution and then grows tax-free. Those are your Roth accounts. That tax-free growth from the Roth can make a tremendous difference in tax savings over your lifetime.

“A couple might have done a tremendous job growing their traditional IRAs and have a great nest egg but aren’t aware of how big their tax bill will be in retirement. Ideally, we’ll spread their wealth across the three accounts to give them the most amount of flexibility.” – Stephen Tuckwood, CFA

What’s Your Spending Plan?

Having a CPA, CFA, and CFP® Professional working together is critical when you’re determining asset allocation. The CFP® Professional builds your plan, the CFA outlines the proper portfolio construction, and the CPA shows you how to do that in the least taxing way possible. Their collaboration will help you understand how your spending plan should be constructed.

“How much income needs to be generated and which tax bucket are you going to pull from first? And what portion will you pull on an annual basis?” – Dean Barber

As a general rule, Dean says that you want your assets that you’re going to be spending over the next three to five years in something that is very safe so you’re not forced to sell some of your growth assets that may be temporarily down in price.

You can’t just take a set-it-and-forget-it approach once your plan has been established, though. It’s pivotal to monitor your plan and make adjustments as needed based on economic conditions and your personal situation.

4. Asset Class Implementation

This brings us to our final point in our discussion about strategic investing through retirement, which is asset class implementation. When should you be passive and when should you be active and how do you determine that?

Active vs. Passive Management

Let’s use U.S. large-cap equity as an example. It’s part of your overall portfolio, so how do you get that exposure? That’s the implementation question. A lot of people use an active mutual fund, which has an underlying portfolio manager that’s actively trying to outperform a benchmark such as the S&P 500.

You can also go with the passive implementation route. That would involve taking more of an indexed approach, where you would buy an ETF that tracks, for example, the S&P 500. You’re not trying to outperform it over time.

“The decision on whether to go active or passive should be based on how efficient you think that particular market is.” – Stephen Tuckwood, CFA

Using the S&P 500 as an example, it’s really hard to beat that benchmark consistently over time for any active manager. In that situation, it would tend to make more sense to lean toward a passive, indexed approach because of how efficient the S&P 500 is. The alpha potential is low.

Let’s compare that to emerging markets. Following that index might not be an optimal approach, so look into bringing in a portfolio manager who can tilt the portfolio to higher quality emerging market names versus the overall emerging markets. There’s more of a premium over time when you tilt the portfolio to higher quality names.

Benefits of Portfolio Tilts and Intentional Risk Taking

When we’re talking about strategic asset allocation, we’re looking at asset allocation over a longer period. But there might be opportunities that the market offers over shorter periods. Maybe there’s a drawdown in the equity market that serves as an opportunity to tilt the portfolio.

Let’s say that the strategic objective is a 60-40 portfolio. Rebalancing helps with this. As one side declines more than the other, it gives you the opportunity to rebalance back to 60-40. Maybe you want to tilt it a little bit more if there’s a great opportunity to go 65-35. That would be the tilt in that situation.

“That’s what we mean by intentional risk taking. It’s that added tilt. You need to be cognizant of that decision and the ramifications of possibly being wrong or if the dislocation persists. What’s the impact on your strategic objective based on that?” – Stephen Tuckwood, CFA

The S&P 500 Equal Weight vs. S&P 500 Cap Weight

For much of 2023, there was a big dislocation between the S&P 500 equal weight and the S&P 500 cap weight. The Magnificent Seven stocks—Microsoft, Apple, Nvidia, Amazon, Tesla, Meta, and Google—drove the stock market for much of 2023.

There are a lot of stocks within the S&P 500 from a valuation standpoint that Dean and Tuck consider to be bargains. They’re undervalued today, but they’re also underperforming compared to the rest of the market.

“If you buy low and sell high, you could tilt toward an equal-weighted ETF versus a cap-weighted ETF to reduce exposure to the highflyers that are out there with P/E ratios that are out of control. You’re adding more to the more value-oriented type of companies.” – Dean Barber

In November 2023, the return on the S&P 500 equal weight almost pulled even with the return of the S&P 500 cap weight. That could be a sign that there’s some value there that’s being recognized by different investors.

Alternative Forms of Risk

The last thing we want to touch on with strategic investing through retirement are alternative forms of risk. This is where it can get trickier from an implementation standpoint. Again, the primary two drivers of the portfolio are equities and fixed income. But there are rare instances like 2022 where that isn’t the case. Both of those types of risk were negative in 2022.

“Normally, we want that offsetting effect where fixed income shields against portfolio losses in a declining equity market. What else can you bring into the portfolio that you can bring in as an asset class that could offset occasions like 2022?” – Stephen Tuckwood, CFA

There are various alternative forms of risk, even in scenarios like 2022. There’s the idea of an illiquidity premium, where you can get added return for locking up capital for longer periods. Public equities and general fixed income are very liquid markets. You can sell any day the markets are open and get a fair price. If you lock up capital into a different vehicle such as private equity or private credit, you should get a more favorable return compared to a more liquid asset.

Another alternative form of risk to consider is real estate. On the equity side, if you really dig down into the S&P 500, there’s an allocation to public REITs in there. It’s just quite small. But the overall market for commercial real estate is huge. It’s just not well captured in that one slice of the equity market.

On the private real estate side, that’s another asset class that can be included in your portfolio. It’s just likely going to be money that’s tied up for a longer period. Real estate transactions are very clunky. It’s not a liquid market.

Recapping the Key Points of Strategic Investing Through Retirement

So, let’s recap these four main points of strategic investing through retirement. Asset allocation is the number one driver of long-term performance. But then you have portfolio tilts. You can tilt heavier toward stocks or bonds, value or growth, international or domestic, etc. And then the asset location is critical from a distribution, spending, and tax perspective.

Ultimately, once you’ve constructed your portfolio, you can look at what alternative asset classes could have a place in your longer-term growth buckets to enhance return and give up a little bit of liquidity. Because the last bucket of money you have is going to be spent five, 10, 15 years down the road. It’s not part of your spending plan in those early years of retirement.

Do You Have Any Questions About Strategic Investing Through Retirement?

If you have any questions about strategic investing through retirement, let us know by starting a conversation with our team below.

Schedule a Meeting

We hope that you found what Tuck and Dean shared about strategic investing through retirement to be informative and can apply it to your unique situation. This will look differently for everyone, but that’s part of the fun of it for our team. We look forward to the opportunity of tailoring each person’s plan toward their needs, wants, and wishes.

Watch Guide | Strategic Investing Through Retirement with Stephen Tuckwood, CFA

00:00 – Introduction
– Proper Portfolio Construction as You Approach Retirement
– Retirement Rules of Thumb for Investing
– Pure Assset Allocation
– Keeping Up with Inflation
– Strategic Asset Allocation
– Asset Location
– Asset Class
– Recapping Today’s Discussion

Resources Mentioned in This Article

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC, does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.